Gambling in the Metaverse

If you have yet to familiarize yourself with the Metaverse, it is a virtual reality world that offers almost everything that can be found in the real world. You can purchase land, run a business, shop, play games, attend concerts, and, you guessed it, gamble. 

While the Metaverse offers virtual casinos with table game and slot offerings, a popular “gambling-related” activity is play-to-earn (P2E) poker. There are a number of virtual poker rooms in the Metaverse that can be accessed after purchasing a corresponding Non-Fungible Token (NFT). This acts as your “entrance ticket” to the venue. Players can then enter tournaments, for free, with a chance to earn rewards that can be used to upgrade items (such as wearables) and NFTs within the Metaverse. I referred to this as a “gambling-related” activity because it is unclear if this meets the definition of gambling from a tax perspective.

Sure, you are playing poker online, but in order for it to be deemed gambling, there must be 1) money earned 2) by placing a wager 3) on a game of chance. While the rewards do have a discernible value, it can be argued that no wager is made to enter these tournaments. Anyone can enter these tournaments each day, without a buy-in, as long as they have access to the necessary NFT. If the player gets knocked out of the tournament, they do not lose any rewards or face any monetary penalty. Players don’t even need to own the NFT. They are often borrowed from another party and any earned rewards are split between the owner and player.

There is no guidance around these types of games (and I don’t believe guidance will be released anytime soon), so we need to make our best assessment based on the facts and circumstances. It seems any rewards generated in play-to-earn style games should be reported as other income, valued at the current conversion rate of the reward, rather than gambling winnings. Any upgrades purchased with rewards, would then be included in the basis of the upgraded item or wearable.

If a player wins 1,000 rewards, valued at $0.05 per reward, it would result in $50 of taxable income at the time the rewards were won. If the player uses these rewards to upgrade a wearable, the basis of the wearable would now be $50. At any point in the future, if the player sells their wearable (or a collection of wearables), they would deduct their total basis from the sale price, to determine their net capital gain or loss. It is important to track the basis of rewards won, as the conversion rate to USD will fluctuate from day to day.

While this is not a recommendation, it seems to be the best interpretation at this time.

These types of rewards in the Metaverse add yet another layer of complexity to the taxation of digital assets. Keeping records, in whatever form, is essential. Even if you are unfamiliar with all the tax nuances, if you accurately track all of your Metaverse activity, a tax professional will be able to help sort through the issues.

We are eagerly awaiting expanded guidance, but I fear even updated guidance will leave many things up for interpretation.